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A Reasonable Valuation In An Expensive Market
A low interest rate environment has driven the prices of stocks up in many instances to valuations that are now starting to look unreasonable. Also, the world is looking more uncertain than it once did. And the market appears to be becoming more volatile day by day.
For those and many other reasons, I recently decided to take a closer look at Philip Morris (NYSE:PM) a company that I have covered in the past (albeit not with Seeking Alpha). The last time that I recommended Philip Morris was several years ago when a lot of smart money was starting to move away from growth stocks and into defensive stocks.
Financial MetricsAn important factor to consider is how Philip Morris stacks up against other companies in the same sector. The chart below compares Philip Morris to other companies in the sector whose shares are also sold on the New York Stock Exchange. A few of my initial impressions:
At an average P/E of around 20 to 21 the sector looks expensive.
Shares of Philip Morris (mostly due to currency risk) are surprisingly more volatile than the broader market as a whole (beta > 1). market).
Philip Morris is attractively valued relative to other companies in the sector.(Source: Yahoo Finance)
Another important factor to consider is the current dividend yield. More important, though, are (1) the sustainability of that dividend and (2) future dividend increases. A few of my takeaways (after analyzing income statements, balance sheets, and cash flows):
A few years ago, Philip Morris had a lower dividend yield ( 4%) than most of the other companies in the sector such as Reynolds, Lorillard, and Altria (6%). market is shrinking and International markets are growing.
The percentage of net income that these companies have used to pay their dividend (payout ratio) has increased substantially over the past few years.
Over the past 4 years (not counting 2014), Philip Morris consistently grew revenues by 9% (2010), 13% (2011), 1% (2012), 3% (2013); earnings per share by 21% (2010), 24% (2011), 7% (2012), 2% (2013); and dividends by 9% (2010), 16% (2011), 15% (2012), 11% (2013). 2014 (and probably Q1 and Q2 of 2015) might have been an off year. Or the regulatory environment and competitive landscape may have dramatically changed.
Prioritizing profitability first, revenues second, and volume third suggests that Philip Morris is a well managed company that will continue to generate cash flow needed to maintain and predictably increase its dividend over time.
Since March 2008 (when Philip Morris became its own company), Philip Morris has been an amazing dividend growth story. In fact, Philip Morris has raised its dividend every four quarters. The company started paying a quarterly dividend of $0.46 in Q3 of 2008 and has raised it every four quarters since then: $0.54 (Q4 of 2008), $0.64 (Q4 of 2010), $0.77 (Q4 of 2011), $0.85 (Q4 of 2012), $0.94 (Q4 of 2013), and $1.00 (Q4 of 2014).
Philip Morris has a strong cash flow and a strong history of growing its dividend. Those two factors also suggest that Philip Morris should not be trading at a discount relative to other companies in the sector.
Philip Morris discontinued cigarette production in the Netherlands and manufacturing operations in Australia this past year. Those two events had a negative impact on 2014 results but should reduce costs moving forward.
Philip Morris shipped 856.0 Billion cigarettes in 2014, down by 2.8%; net revenues were $29.8 Billion, up by 2.0%; and Adjusted Diluted EPS were $5.02, up by 7.8%, according to its 2014 Annual Report. Importantly, though, the reported increases (relative to the previous fiscal year) do not consider the negative impacts currency had on the results.(Source: Yahoo Finance)
International BusinessesPhilip Morris conducts all of its business outside of the United States. On one hand, that exposes the company to currency risk (discussed below); on the other hand, many emerging markets could provide substantial growth for Phillip Morris moving forward.
The chart below shows the relative percentages of the company's income attributable to each reportable segment. Briefly:
European Union covers all the EU countries except for Slovenia, Bulgaria, Croatia and Romania, and also comprises Switzerland as well as Norway and Iceland (which are linked to the EU through trade agreements).
Eastern Europe, Middle East Africa ("EEMA") includes Eastern Europe, the Balkans (Slovenia, Bulgaria, Croatia and Romania), Turkey, the Middle East and Africa and the international duty free business.
Asia covers all other Asian markets as well as Australia, New Zealand and the Pacific Islands.
Latin America Canada covers the South American Continent, Central America, Mexico, the Caribbean, and Canada.(Source: Philip Morris 2014 Annual Report)
Annual Report TakeawaysAfter seeing the above chart at the beginning of the Annual Report, I searched for data and language that would either confirm or refute some of the assumptions that I have made about PM's operations and management. A few of my takeaways include the following: